Life insurance proceeds are generally part of your estate and may be
subject to estate taxes depending on the size of your taxable estate. This
influx of cash to the estate, while usually quite large and often needed for
funeral expenses, taxes and debts, is a cause for much confusion. In some
cases, the life insurance proceeds are what increases the estate to the size
where it starts to owe taxes.

Just how the life insurance is owned and paid for can nearly double its
monetary value if estate taxes do not have to be paid on it. Estate tax rates
start at 33% and can rise to 48% for large estates.

How do you avoid these estate taxes? Set up an Irrevocable Life Insurance
Trust, commonly called an ILIT. Note that an ILIT is irrevocable which means
you cannot change your mind after it is established. From this restriction
and the nature of the format of life insurance come the many tax and
financial advantages.

Here is how it works

Determine your specific need. Often an
ILIT is used as the most effective way possible to pay estate taxes. Usually
premiums represent pennies on the dollar of benefits paid on your death.
Using the insurance proceeds to cover estate taxes may be a better choice
than having to liquidate other assets.

Set up the trust. You need
professional assistance in setting up an ILIT. Even if your insurance company
offers to draft the documents, be sure your attorney reviews them. Your
attorney will be more familiar with your situation and be more aware of local
laws affecting your estate. You will have to select a trustee for the ILIT.
Usually personal trusteeship of the trust is the most cost efficient, but
your trustee needs competent advice for the simple reporting requirements.

Fund the trust. The trust owns the
life insurance policy and pays the premiums. You may be able to make annual
gifts to the trust to cover the premiums. However, there are special rules
about this and you should cover this issue with your attorney.

Buy the insurance policy. The trust purchases
life insurance on your life with its assets. Along with being the owner, the
trust is the beneficiary of the policy and your heirs are the beneficiaries
of the trust. When you are considering what type of life insurance to buy,
along with term and cash value whole life, consider a "second-to-
die" policy. This is a relatively new form of life insurance policy and
can be very attractive as part of a total family estate plan.

Final thoughts
No one likes to think about dying. And buying life insurance is usually
not something most people eagerly do. However, life insurance can provide the
funds needed to care for your loved ones after you pass on. Life insurance
trusts have become a common way to make sure you have structured your affairs
to minimize estate taxes and maximize what is available for your loved ones.